The 20 States Real Estate Investors Should Avoid Unless They Love Filing Tax Returns

By Dr. Jim Dahle, WCI Founder

Dealing with the federal income tax code is bad enough, but state tax authorities and regulations sometimes make dealing with the IRS seem like child's play. The sheer volume of regulations and returns required to enjoy passive income from states outside of your own keeps many white coat investors out of certain private investments. They also make others (including yours truly) who were previously preparing their own tax returns hire professional assistance.

If you're staring at yet another 60-page K-1 packet and wondering what states you now need to file in, this is the post for you. Two things to know as you read this post. First, I'm not an accountant. I don't even do my own tax returns anymore. Second, states change their regulations frequently, and it is extremely difficult to keep a post like this up to date with every possible little change. If you notice an error, please post it in the comments, and we'll try to keep things updated as best we can as laws change.

Resident and Non-Resident Tax Returns

Most states that have an income tax (41 states plus the District of Columbia) allow you to file as a resident, a part-year resident, or a non-resident. Most of the time, you will file as a resident of one state and a non-resident in all other states that require you to file. All income will be taxable in your state, but federal laws mandate that you get a tax credit or deduction of some type for taxes paid to other states. That means you will not have to pay taxes in two states on the same income.

However, since some states have a higher tax rate than others, you may not get as much of a credit as you paid in taxes (if the non-resident tax rate is higher) or you may have to pay additional tax on that income (if the resident tax rate is higher). Note also that many states (including my own) do not give any sort of preferential tax rates for investment income. While the federal tax code offers lower long term capital gains and qualified dividend tax rates, all income in Utah is taxed the same at 4.65% [2024].

More information here:

How Are Investments Taxed

Earned Income Is Different

You also need to know that income earned as an employee as a non-resident is treated differently. It can actually be really complicated, especially in today's era of telecommuting. There were also a lot of temporary rules associated with the pandemic that are now expiring. As a general rule, if you are working there for more than 30 days (other than soliciting sales), you're almost surely going to be filing a state tax return in that state, and your employer may need to withhold taxes for that state.

I assure you that this is a big hassle for small businesses. About half the states have some sort of threshold (minimum number of working days or income earned) before the filing requirement kicks in, but more than 20 states require you to file even for a trivial amount of earned income made in a single day. There are also a bunch of reciprocal agreements, where states have agreed not to make residents of certain other states working in their state file a return. These are generally agreements where metropolitan areas span multiple small states, and it is not uncommon to work in one state while living in another. Note that New York, New Jersey, and Connecticut DO NOT have an agreement. Some examples of agreements include:

• The District of Columbia, Maryland, and Virginia
• Illinois, Iowa, Kentucky, Michigan, and Wisconsin
• Indiana, Kentucky, Michigan, Ohio, Pennsylvania, and Wisconsin
• Iowa and Illinois
• Kentucky, Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia, and Wisconsin
• Maryland, the District of Columbia, Pennsylvania, Virginia, and West Virginia
• Michigan, Illinois, Indiana, Kentucky, Minnesota, Ohio, and Wisconsin
• Minnesota, Michigan, and North Dakota
• Montana and North Dakota
• New Jersey and Pennsylvania
• North Dakota, Minnesota, and Montana
• Ohio, Indiana, Kentucky, Michigan, Pennsylvania, and West Virginia
• Pennsylvania, Indiana, Maryland, New Jersey, Ohio, Virginia and West Virginia
• Virginia, the District of Columbia, Kentucky, Maryland, Pennsylvania, and West Virginia
• West Virginia, Kentucky, Maryland, Ohio, Pennsylvania, and Virginia
• Wisconsin, Illinois, Indiana, Kentucky, and Michigan

These agreements can be complicated. Note that many states are listed more than once. Also, see how rare these agreements are out West. There are no agreements west of the North Dakota-Montana agreement and only a few west of the Mississippi. But if the states you live and work in are on that list, you should probably seek out more information on the reciprocal agreements applicable to your state. Note also that the agreements are not automatic. You usually have to file a state-specific form to take advantage and ensure your employer withholds state taxes appropriately.

Passive Income Taxation

Besides being employed in another state, there are a handful of ways that you can incur a state tax filing obligation in another state. These include receiving income from:

1. A partnership, LLC, or S Corporation based in another state.
2. A trade or business in another state.
3. Rental property in another state.
4. The sale of real estate in another state.
5. Lottery or other gambling winnings from another state.

In my case, I've had to file in other states for each of the first four reasons. This is what we're talking about today. Note that interest is not on the list. Just earning interest in another state does not create a requirement to file there. While private debt funds are not tax-efficient, their returns are also primarily interest and, thus, not generally taxable in other states.

You should also be aware that some partnerships send out K-1s for many states. Just getting a K-1 for that state DOES NOT by itself create a requirement to file there. First, many K-1s, particularly equity real estate K-1s, list a loss. You don't have to file a return if you didn't make any money (except in a few states). Second, many partnerships send out state K-1s to every partner in a partnership because some of the partners are residents of that state, not because there is actually any partnership income attributable to that state. You don't have to file for that either. You actually have to read and understand what the K-1 is telling you to determine if you must file in that state. Now you see why I hired professional help to do this.

Looking at a K-1

Before we get into the long lists of states below, let's glance briefly at a Form K-1. I'll pick one of the more complicated ones I've received, this one from the Origin Income Plus Fund for 2022:

Real estate investments have and can put some sort of investment income into many of the boxes on the K-1. These include boxes 1, 2, 3, 4, 5, 6, 8, 9, and 10. All of this is taxable income. Note that box 19 (distributions) is not taxable income unless it also shows up in the other boxes. Even if the total of your boxes 1-10 is a negative number, you may still have taxable income, and if it is attributed to a particular state, it may give you a requirement to file in that state. One dollar in box 6a may cause you to have to file in a state, even if you have a -$4,000 in box 2.

More information here:

Real Estate K-1s — Here’s What My Depreciation Really Looks Like

Tax-Free States

Some states don't have any state income tax. You'll never have to file a tax return in those states, because there isn't one. These states include:

• Alaska
• Florida
• Nevada
• New Hampshire*
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

Note that while New Hampshire doesn't tax earned income, it does tax dividends, interest, and the business income you would see from a typical real estate partnership. You may also see additional taxes in some of these states (specifically Nevada, Ohio, Texas, and Washington)—either in the form of a corporate income tax or a “gross receipts” tax. This varies by the form of the business.

For all the other states, they are not very generous. You shouldn't be surprised; they have no incentive to be generous to non-residents. This is taxation without representation we're talking about here. I've divided the remaining states into three categories:

1. No threshold states
2. Stingy threshold states
3. Generous threshold states

For all practical purposes, the stingy threshold states are pretty much the same thing as the no threshold states.

No Threshold States

Seventeen states require you to file for any income amount in that state. One dollar of income means you have to file a return. This really stinks, because it will often cost you more to file the return than you will actually pay in tax. Some states also have ridiculously onerous tax penalties you may not expect. In Michigan, for example, the penalty for not filing timely quarterly estimated payments is 25% of the tax due! If you are required to file a federal return and you have income attributable to any of these states, plan on filing a return in these “no-threshold” states:

• Arkansas
• Colorado
• Delaware
• Illinois
• Indiana
• Kansas
• Louisiana
• Maryland
• Michigan
• Mississippi
• Nebraska
• New Mexico
• North Dakota
• Ohio
• Rhode Island
• South Carolina
• Utah

Stingy Threshold States

Sixteen states seem a little bit kinder in that you don't have to file until you meet a certain threshold, usually an amount of either gross or state-sourced income. However, when you dig into what the thresholds actually are, they're really no different from the no threshold states for most of us. These thresholds are constantly changing, so be sure to double-check any information you read here, using the links below. These are the “stingy threshold” states:

• Alabama
• Arizona
• California
• Connecticut
• Georgia
• Hawaii
• Massachusetts
• Montana
• New Jersey
• New York
• North Carolina
• Pennsylvania
• Vermont
• Virginia
• West Virginia
• Wisconsin

At the time this post was written, these were the thresholds for non-residents. However, I have included links that should allow you to double-check the information on official state websites, as it is all subject to change at any time.

Alabama

The law states that “Nonresidents must file a return if their Alabama income exceeds the allowable prorated personal exemption.” That pro-ration is (Alabama Income/Total Income) * either $1,500 (single) or $3,000 (married). Bottom line: if your total income (not Alabama) is more than $1,500-$3,000 and you have Alabama income, you're going to need to file there.

Arizona

The Arizona threshold is a prorated amount of the federal standard deduction, but it excludes income that Arizona doesn't tax, such as military pay or Treasury interest. The proration is again the percentage of Arizona income to total income. Bottom line: if your total income exceeds the standard deduction and you have Arizona income, you're going to need to file there.

California

This threshold varies but it is based on your total income (not just California income) and number of dependents. It ranges from $21,000-$77,000. If you're under that threshold, there is a second threshold based on Adjusted Gross Income. See the link for more details on this complicated rule. The bottom line is that most working white coat investors with any California income are going to have to file there.

Connecticut

The threshold is $15,000 (single) and $24,000 (married) for total income, not just Connecticut income. The bottom line is if you have Connecticut income, you're probably going to have to file there.

Georgia

If you are required to file a federal tax return and you have Georgia-sourced income, you will need to file a Georgia return. The Georgia threshold only applies to earned income for an employee of less than $5,000 and less than 5% of total wages earned.

Hawaii

Hawaii's law is a little unique. There is a threshold ranging from $3,300-$9,000 of Hawaii-sourced income, but there is also a requirement to file just for doing business (including rental real estate) in the state—even if you don't make any money! That would catch investors in private syndications or funds with properties there, and it actually makes Hawaii's law perhaps the most onerous of all when it comes to passive income.

Massachusetts

You'll have to pay if your Massachusetts-sourced income is more than $8,000 or if your Massachusetts-sourced income was more than your personal exemption amount ($4,400-$8,800) multiplied by the ratio of your Massachusetts income to your total income. That pro-rated amount could easily be a trivial amount if you are a high earner. Imagine you made $5 of your $300,000 income in Massachusetts. You have to file. Most white coat investors with Massachusetts income should plan to file there.

Montana

Any Montana source income plus a federal gross income of more than $5,540-$17,000 requires you to file a Montana return. That's going to be most white coat investors with Montana income.

New Jersey

If you have New Jersey-sourced income and a gross income of more than $10,000-$20,000, you will need to file in New Jersey. That's going to be most white coat investors with New Jersey income.

New York

If you have New York-sourced income and a New York adjusted gross income larger than your New York standard deduction, you must file in New York. Again, most white coat investors with New York income will have to file.

North Carolina

If you had North Carolina-sourced income and total gross income more than the federal standard deduction, you must file in North Carolina.

Pennsylvania

Pennsylvania is pretty strict. The state doesn't care whether you have to file a federal return. If either of these two requirements are met, you must file in Pennsylvania:

1. You received total Pennsylvania gross taxable income in excess of $33 during 2023, even if no tax is due with your state return
2. You incurred a loss from any transaction as an individual, sole proprietor, partner in a partnership, or as a Pennsylvania S corporation shareholder

Thirty-three dollars is an awfully low threshold, but the second part is worse since it requires you to file for an investment property kicking off no taxable income due to a depreciation loss.

Vermont

This is a weird one. If you have to file a federal return AND earned $100 or more in Vermont-sourced income OR “more than $1,000 in gross income as a nonresident,” then you must file. I guess if you made $1 in Vermont and made $1,100 in your home state, you'll have to file. Not very generous.

Virginia

This commonwealth is stingy, too. Any Virginia income plus total Virginia Adjusted Gross Income of more than an amount a little less than the standard deduction creates a requirement to file. For 2023, the threshold amounts were $11,950 for singles ($1,900 less than the standard deduction) and $23,900 for Married Filing Jointly ($3,800 less than the standard deduction).

West Virginia

If you have West Virginia income, you will need to file, even if you don't have a federal filing requirement. The only exception is if your West Virginia Adjusted Gross Income is less than your total exemptions ($2,000 per exemption, or $500 if you have no exemptions). I can't imagine there is a single white coat investor who's going to get out of filing due to that threshold.

Wisconsin

Another odd one: if your Wisconsin gross income is over $2,000, you will need to file. The example given in the instructions is as follows:

“Nonresident A receives a Schedule 3K-1 from a Wisconsin partnership reporting rental income of $1,800. The partnership's gross income is $500,000 and deductible expenses are $400,000, resulting in total partnership net income of $100,000. Nonresident A's ownership percentage in the partnership is 1.8%. Nonresident A's share of partnership gross income is $9,000, which is above the filing requirement. Nonresident A must file Wisconsin Form 1NPR.”

I don't know whether to put that one in the stingy or generous category, but because it's so complicated, I'm throwing it in with the stingy states.

Generous Threshold States

These are the eight states (and one district) that may actually give you a break if your state K-1 only has a little income on it.

• District of Columbia
• Idaho
• Iowa
• Kentucky
• Maine
• Minnesota
• Missouri
• Oklahoma
• Oregon

District of Columbia

Non-residents don't have to file a DC return at all.

Idaho

I like Idaho's law. It's really simple. If you make $2,500 or more in Idaho, you have to file. I wish more states did it this way.

Iowa

Iowa's law is also pretty good. If you have Iowa-sourced income of less than $1,000, you're pretty much off the hook to file. It's possible to be off the hook even if you have more than $1,000 if your total income is less than $13,500-$32,000.

Kentucky

In Kentucky, the total income threshold is related to family size and ranges from $14,580-$20,000 [2024]. If you're above that AND your Kentucky income is over $2,980-$4,760 (depending on age), you will have to file. It's a little confusing, but it's actually a pretty generous law.

Maine

Maine has a $3,000 minimum Maine-sourced income before you have to file.

Minnesota

Minnesota may have one of the most generous laws. If you have less than $13,825 in Minnesota-sourced income [2024], you don't have to file there.

Missouri

You don't have to file in Missouri if you have Missouri-sourced income of less than $600 OR a Missouri Adjusted Gross Income of less than the amount of your standard deduction plus personal exemption. This one is a little confusing because the standard deduction we're talking about here is the federal standard deduction ($13,850-$27,700) [2023], which is obviously way more than $600. However, bear in mind what “Missouri Adjusted Gross Income” means. It's basically your total AGI with a few tiny tweaks, not your Missouri-sourced income.

Oklahoma

You must file if you have an Oklahoma source income of more than $1,000.

Oregon

If your Oregon source income is more than your federal standard deduction, then you must file an Oregon return. Very generous. The state will now let you pump your own gas, too.

Composite Returns

Some states also offer the option for composite returns, which could eliminate your need to file in that state. If every entity paying you taxable income in that state files a composite return on your behalf, you don't have to file individually. The downside of a composite return is that taxes are paid at the highest possible tax rate. So, if you're not in the top state tax bracket, there is a cost here. You'll have to weigh that cost against the cost of filing a return in that state, but I suspect most of the time, it's probably still worth doing the composite return when you can. The following 18 states offer the ability to file a composite return:

• Alabama
• Arizona
• Connecticut
• Delaware
• District of Columbia
• Idaho
• Massachusetts
• Michigan
• Nebraska
• North Dakota
• New Hampshire
• New York
• Oklahoma
• South Carolina
• Tennessee
• Texas
• Utah
• Vermont
• Wisconsin

Note that just because an investment CAN file a composite return, that doesn't mean they WILL file one. Be sure to ask.

How to Use This Information

There are two ways to use the information in this blog post. The first is after you get a K-1, you can look at that particular state and see if you need to file. The second is to look at this before you make an investment—particularly an investment into a business, partnership, or passive real estate opportunity that does business in other states. If you can get the investment manager to tell you what states it does or will be doing business in, you can look them up on this list to determine how likely it is that you will have to file an additional state tax return before you invest.

While you shouldn't let the tax tail wag the investment dog, don't underestimate the cost and hassle of filing a dozen state tax returns (or paying someone else to do so).

More information here:

You Should Do Your Own Taxes at Least Once – Here’s How I Do Mine

States to Avoid for Private Investments (If You Hate Filing Taxes)

If you want to minimize your tax filing burden (not necessarily the actual tax burden), you may wish to avoid investing in the following states. Note that an exception exists for any state in which you already have to file a return due to your residence(s), businesses, or other investments. These are states that have either no filing threshold or a stingy threshold AND are not on the composite return list. That still leaves a lengthy list of 20 states to avoid.

Note that these are not necessarily high tax states or bad places to invest. But they are places that if you do invest, you will almost certainly be filing an additional tax return for doing so.

• Arkansas
• California
• Colorado
• Georgia
• Hawaii
• Illinois
• Indiana
• Kansas
• Louisiana
• Maryland
• Mississippi
• Montana
• New Jersey
• New Mexico
• North Carolina
• Ohio
• Pennsylvania
• Rhode Island
• Virginia
• West Virginia

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What do you think? How much of an impact does having to file an additional state tax return have on your investing decisions? What states do you avoid and why?